Health savings accounts (HSAs) were intended to be used to help pay for medical expenses. But they’re actually the best retirement account in existence. Unlike all other tax-advantaged accounts, they provide a triple tax benefit:
- Tax-deductible contributions
- Tax-free growth inside the HSA
- Tax-free withdrawals when used for medical expenses
Limits
If you withdraw your money on or after the date you turn age 65 for non-medical expenses, you pay regular income tax on the money, the same as for a traditional IRA.
Non-medical withdrawals before age 65 are subject to a 20 percent penalty, so don’t do them.
High Deductible Health Insurance
Your HSA must be paired with a high deductible health insurance plan, which may be provided by your employer or obtained on your own. HSAs work especially well when paired with high deductible Obamacare plans.
Treat It as a Retirement Plan
You should always fully fund your HSA each year until you enroll in Medicare and ideally take few or no distributions. Remember to operate it as a retirement plan, because it is a terrific one, as you can see:
- Sam and Jane Smith are age 50, start today, and contribute $7,750 a year to their HSA. At 6 percent earnings per year, they have $209,785 at age 65.
- Bill and Lacy Jones are age 30, start today, and contribute $7,750 a year to their HSA. At 6 percent earnings per year, they have $975,004 at age 65.
The couples above did not use any of the HSA accumulations for medical expenses in the intervening years because they wanted to treat the HSA as a retirement plan.
Inflation Adjustments
The amount you may contribute to an HSA is adjusted for inflation each year. Here are the HSA contribution amounts for 2023.
Account holders who are age 55 or over may make catch-up contributions of $1,000 in addition to their regular contributions.
The One-Time IRA-to-HSA Rollover
To help you fund your HSA, there is a special rule little known to the public: You are allowed to roll over funds from your IRA to your HSA once during your lifetime. This is called a qualified HSA funding distribution (QHFD).
No tax need be paid on the rollover. Thus, if you later withdraw the funds from your HSA for medical expenses, you’ll never have to pay taxes on them. Tax-free withdrawals are the best!
How Much Can You Roll Over?
The maximum amount you may roll over is the amount of the year’s HSA contribution limit. This is a lifetime limit, not a limit per IRA.
Thus, for 2023, the maximum rollover is $3,850 if you have individual coverage or $7,750 if you have family coverage. If you’re age 55 or over (as of the end of the year), you can add a $1,000 catch-up contribution for a total of $8,750. This is not a life-changing amount of money, but it’s not nothing either.
If you have individual coverage when you make your rollover, but you switch to family coverage later in the year, you can make a second rollover. But your total rollover can’t be more than the contribution limit for family coverage plus any catch-up contribution.
The ideal time to do an IRA-to-HSA rollover is when you’re eligible for an HSA catch-up contribution. This eligibility goes from the year you reach age 55 through the month you reach age 64 (assuming you intend to enroll in Medicare at age 65). This will give you the maximum rollover amount.
Rollover Deadline
You must complete your IRA-to-HSA rollover by December 31 of the current year. This differs from regular IRA or HSA contributions, which may be made by the due date for your tax return for the following year.
Impact of Rollover
The rollover amount isn’t included in your income, isn’t deductible, and reduces the amount that can be contributed to your HSA for the year. For example, if you’re under age 55 and you roll over $7,750 to your family HSA, you can’t put any more money in your HSA that year.
If your employer contributes to your HSA, make sure the amount you roll over plus your employer’s and your own contributions (if any) are less than the annual limit. If you contribute over the annual limit, you must pay a 6 percent excise tax on your excess contribution that year and in each year you fail to remove the excess contribution and its earnings.
The excess contribution is also considered taxable income. If you correct the error before the tax filing deadline for the year, however, you may be able to avoid income tax and the excise tax for that year.
Which Retirement Accounts Can be Used for HSA Rollovers?
You can roll over funds from your traditional IRA, but not from a SEP-IRA or SIMPLE IRA to which your employer (or you, if self-employed) contributes during the year.
You can also do HSA rollovers from a Roth IRA, but there is no reason to do so, since Roth withdrawals are already tax-free.
You can’t do a direct rollover from employer-based retirement accounts such as a 401(k), 403(b), or 457 account.
But you could roll over money from such an account to your IRA and then roll it over to your HSA.
After the death of an IRA owner, an IRA-to-HSA rollover may be made for the benefit of the IRA beneficiary. The rollover counts toward the annual required minimum distribution (RMD) for the IRA.
If you own two or more IRAs and want to use money from more than one to fund your rollover, you must consolidate your IRAs into a single IRA and then make your rollover from that IRA.
Note that the account holder must own both the HSA and the IRA to make the rollover—for example, a spouse cannot roll over IRA money into the other spouse’s HSA.
The Testing Period
One potentially troublesome requirement is the “testing period.” You must be enrolled in an HSA-eligible plan upon the month of your IRA-to-HSA rollover and stay enrolled for at least 12 months following the month of the rollover date. For example, if you do a rollover to your HSA on August 10, 2023, your testing period begins in August 2023, and ends on August 31, 2024.
If you cease to be enrolled in your HSA plan during the testing period, the entire rollover must be included in income and is subject to an additional 10 percent penalty tax.
Problems with the testing period usually crop up for people who reach age 65 and enroll in Medicare during the 12- month testing period. Once you enroll in Medicare, you are not allowed to make any contributions to your HSA. If you do so during the testing period, your rollover is disqualified, and the testing period is failed.
The obvious way to avoid such problems is to plan ahead. Make sure you do your rollover at least 12 months before the month you turn age 65 (unless you plan on delaying enrolling in Medicare because you have other coverage). If you do delay Medicare beyond age 65, note that you’ll receive six months of retroactive Medicare coverage when you do enroll. You can’t make HSA contributions for those months.
How to Do the Rollover
An IRA-to-HSA rollover must be done as a direct transfer. This means that it must be initiated by your IRA custodian and performed as a trustee-to-trustee transfer.
The money should never be in your hands. Request and complete a transfer form from your HSA provider who forwards it to your IRA custodian. Your IRA custodian then sends a check directly to your HSA provider.
The rollover is listed as a qualified HSA funding distribution on line 10 of Form 8889, Health Savings Accounts (HSAs), for the year in which the distribution is made.
Spouses and IRAs
There is no such thing as a joint HSA.
Most married couples have a single HSA with family coverage in the name of one spouse.
But spouses may each have their own HSAs. Spouses can each roll over funds from their own IRA to their own HSA, but not to each other’s HSAs.
Should both spouses desire family coverage, they will share one family HSA contribution limit equal to the limit for family coverage. The limit is divided equally unless spouses agree otherwise.
Each spouse over age 55 also qualifies for an annual catch-up contribution, which must be made to his or her own HSA.
Takeaways
Here are five takeaways from this article.
- HSA holders are allowed to make a once-in-a-lifetime rollover of funds from their IRA to their HSA, up to the annual HSA contribution limit for the year.
- The rollover amount isn’t included in income, isn’t deductible, and reduces the amount that can be contributed to the HSA for the year. The advantage is its use for medical expenses, which avoids taxes and turns that otherwise taxable income into tax-free income.
- IRA-to-HSA rollovers can be done with a traditional or Roth IRA, but not with an active SEP-IRA or SIMPLE IRA. Direct rollovers from employer-based retirement accounts such as 401(k)s, 403(b)s, or 457 accounts are not allowed.
- The HSA owner must be enrolled in an HSA-eligible plan upon the month of the rollover and must stay enrolled for at least 12 months following the month of the rollover. Failure to satisfy the testing period results in the entire rollover being included in income and an additional 10 percent penalty tax.
- IRA-to-HSA rollovers must be completed by December 31.
